10/30/22 10:07 AM EDT

SUNDAY NIGHT REIT READ | UPDATED INVH MODEL ASSUMPTIONS | 10.30.22 (INVH, MPW)

Rob Simone, CFA

Takeaway: Publishing early, there's football to watch later. Prepare yourselves to accept LSD, perhaps even flat earnings growth next year at INVH

Hedgeye Cartoon of the Day: Hike!

It is 10.30.22, and Active Short MPW is overvalued by approximately ~$11.59/share. We share our thoughts from the 3Q22 call below. Awaiting the 10-Q filing which we think is far more important. Apologies ahead of time for the lengthy write-up, but in our view we all need to carefully evaluate what these guys say.

WEEKLY VALUATION HANDBOOK PDF LINK

Ticker: INVH

Company Name: Active Short Invitation Homes

Subsector: Single Family Rentals (SFR)

Headline: Prepare yourselves for just +3% Core FFO earnings y/y in FY23

INVH is our second favorite short idea, but would easily be the first if not for #1's unique situation. We think both the buy- and sell-sides are very offsides on this one. Admittedly the whistleblower case has become a sideshow at this point but remains a tail risk.
After updating our model post-3Q22 results we are modeling just +3% y/y Core FFO growth for INVH in FY23, which is well-below the +10% currently implied by FactSet consensus. We have not hit the downward estimate revision cycle, nor the outright downgrade cycle. Depending on the information provider used and excluding Hedgeye, we count 19 of 21 sell-side recommendations at "Outperform, Buy, Overweight, etc," and no "Sells."
A few considerations on Core FFO:

When incorporating INVH's revised outlook for property taxes up +7% to +8% y/y in FY22, on our math this drives assessed values in the same store pool that imply ~$385/home/month in tax expense in 4Q22 vs. ~$342/home/month in 3Q22. Rolling that step-up forward with just +3% embedded annual compounding drives nearly +12% y/y growth in property taxes in FY23. We do not expect an exceptional "win rate" on tax appeals next year. Property taxes comprise ~50-55% of annual operating expenses.
Combined with continued above-average R&M, turnover and utilities expense growth, we are modeling ~8.5% y/y growth in core operating expenses for FY23.
Our model assumes +3.7% y/y growth in SSRev (average rates +5.2% y/y, -80bps y/y in occupancy, +70bps in higher bad debt expense).
This translates into +1.5% SSNOI growth for FY23. According to FactSet the Street is at +4.7%. We do not buy for a second that INVH, or any of SFR for that matter, will generate that level of SSNOI growth next year under HSD SSExp growth.
We expect more pushback on the top-line, but if we are right about the growth in property tax expense which seems pretty straightforward, there is little hope for +4.5% to +5.5% SSNOI growth next year. Numbers need to come down, and by a significant margin.
Lastly, these estimates assume no incremental opex hit from non-recoverable hurricane expenses. We see upside (negative hit) to the ~$19 million accrual taken in 3Q related to hurricane Ian. Just 15 days before earnings INVH said it had "identified limited damage," and that turned into a ~$0.03/share charge.

Lastly, we think AFFO will be flat y/y and are assuming an increased maintenance capex burden all in. Cost to maintain per home is clearly trending higher in general, and it has been our view that a significant portion of INVH's portfolio has built up a "deferred capex/maintenance liability" over the last ~5 years and particularly through COVID. Search for and look at the testimonials online.
In the meantime we await the judge's decision on whether the whistleblower case moves forward. Based on our conversations we expect that decision by the end of 1Q23 given a crowded docket, and that it will not be dismissed.

Figure 1: INVH Core FFO & AFFO Projections

PDF LINK

Source: Company Reports, Hedgeye Estimates

Ticker: MPW

Company Name: Active Short Medical Properties (Dis)Trust

Subsector: NNN Hospitals

Headline: Review of 3Q earnings call + questions

Feel free to ask the company any of these questions. First general observation is that the CEO had noticeably shorter prepared remarks and none of the usual operator-by-operator commentary. In our experience (at PGRE) a noticeable shortening of the prepared remarks is usually deliberate - either it's a strategy to prompt fewer questions or the lawyers recommend you keep it brief so as not to expose yourself amidst bad news. That's just our experience. But with that said:

Prepared Remarks:

Ed Aldag, CEO: "This is a long-term investment and while we focus along with our operators on the month-to-month, quarter-to-quarter metrics, we are more focused with the long-term strength of our portfolio of assets. It can become too easy to lose the forest through the trees by myopically focusing on a monthly spike in contract labor or coverages quarter-after-quarter. Our underwriting and managing of these assets are not done in a vacuum, nor on a quarter-to-quarter time span. We see the forest."

Hedgeye: Steward has been distressed since the mid-2010's. Prospect has been distressed since at least 2018. If a system in MPW's ~440 hospital portfolio falls (fails) and needs a loan from MPW, does it make a sound?

Ed Aldag, CEO: "We own Pipeline's four Los Angeles hospitals. We remain confident in Pipeline as an operator especially considering the value of our hospital properties that serve a vital need in their respective L.A. communities. We understand the decision to restructure as it will provide this flexibility and implement sustainable strategies for the corporation going forward. We fully expect that our rent will continue to be paid and our hospitals will continue to serve their respective communities during the duration of the bankruptcy process."

Hedgeye: Per the bankruptcy filings, the CA hospitals are generating less than ~$3 million of TTM EBITDAR (before overhead) against at least ~$15 million of annual rent. The SLB deal was funded by MPW just a year ago, apparently into a dramatically over-levered situation with little EBITDA to service plain-vanilla debt. The proceeds were intended to retire a portion of that existing debt. Within a year Pipeline declared bankruptcy.

Ed Aldag, CEO: "Last quarter, we provided an investor update report on our website that detailed some of these occurrences where we've had -- needed to replace or transition operators, not all of which were the result of bankruptcy. In almost all of these situations, there was no interruption of services provided to the communities by these essential assets. Rent continued to be paid and we were successfully able to transition the in-place lease agreements to new tenants."

Hedgeye: Would the rent have been paid absent loan or other direct support from MPW? What were your "all-in" returns inclusive of the funded loan principal (such as with Adeptus)? We would guess "no" on the first question, likely resulting in BK filings, and we are sure "negative" is the answer to the second question.

Ed Aldag, CEO: "Another very important point to note is that the coverages for our total portfolio and each separate category of hospitals saw an increase in coverage during the second quarter over the first quarter."

Hedgeye: What were the actual corporate EBITDAR coverages using both rent and interest, both before and after maintenance capex? This is the metric that matters for cross-defaulted master leases with a parent guarantee, as MPW itself admitted on the 2Q22 earnings call.

Ed Aldag, CEO: "... let me outline the strong operating performance that Steward is reporting to us on. Adjusted EBITDA for the second quarter was approximately $51 million. The third quarter expect – is expected to be more than $30 million. Fiscal year 2022 unadjusted EBITDA is projected to be between $50 million and $80 million. Contract labor in Q3 fiscal year 2022 has decreased 30% from Q1 FY 2022 run rate and is expected to decline an incremental 20% in Q4, resulting in a 50% decline since the first quarter of this year. Steward is also forecasting un-adjusted EBITDA of more than $350 million for fiscal year 2023."

Hedgeye: So much here:

Why switch from citing EBITDAR on the 2Q call to EBITDA on 3Q?
Why mention both adjusted and unadjusted EBITDA within the same paragraph? What are the adjustments? All of the adjustments.
Does EBITDA include the effect of GAAP or cash rent + interest at Steward? Cash rent under the Steward lease is higher than GAAP.
If contract labor is implicitly being cited as a driver for increased profitability at Steward, why is it EBITDA still falling 3Q/2Q despite "increased volumes" and a "good boost in revenues?"
In general, why not just disclose the backup financial data and/or financials underlying these numbers, so that analysts and investors can evaluate their validity? We think we know why, but would just highlight that our read of section 39.6 of the Steward master lease (Figure 2 below) makes it clear MPW has the ability to disclose. It chooses not to. Why?
We have strong conviction that Steward is generating an annual unadjusted EBITDAR run-rate of ~$300 to $350 million today, implying that it is burning ~$300 to $400 million of cash annually after cash rent, interest and maintenance capex. Prove us wrong. We don't think they can or want to try.

Steve Hamner, CFO: "This morning, we reported normalized FFO of $0.45 per diluted share, in line with our prior expectations."

Hedgeye: What was included in the ~$23.5 million gain/FV adjustments line? This was orders of magnitude larger than "normal" and amounted to a ~$0.04/share of FFO benefit in the quarter. Absent this amount, would MPW have "missed?"

Steve Hamner, CFO: "As we discussed in detail on last quarter's call, during this time, Steward's cash flow has been burdened by having to repay to CMS the vast majority of map advances approximating $450 million, delayed Medicaid reimbursement in Texas of about $70 million, the revenue impact of state of Massachusetts mandated elected procedure restrictions earlier this year. And finally, Steward's $300 million-plus cash investments in and working capital support for the five acute care hospitals in South Florida acquired about a year ago."

Hedgeye: As we have written about extensively, this statement is disingenuous in our view, if not an outright lie. Subsequent to the 2021 acquisition of the 5 Tenet Florida hospitals, MPW invested another ~$250 million in "capex" through 3Q22 in the form of loans that are never intended to be paid back, but are instead tacked on to the lease base. They are massively negative NPV fundings, in our view, given the long-term nature of the lease and inherent credit risk of Steward and high probability of default. Triple-net REITs should have little or no capex which is the obligation of the operator, and for sure should not be funding capex at ~20% of the total purchase price. Bigger picture, however, MPW essentially refunded Steward for its ~$200 million share of the ~$1.1 billion SLB + now additional working capital it seems. You cannot cite a non-use of cash by Steward, given that it was refunded by MPW, as a reason for lack of liquidity at Steward. That is patently absurd and should be challenged aggressively.

Steve Hamner, CFO: "Remember that HCA valued Steward's Utah operations and solely the Utah operations at $850 million. This transaction ultimately did not occur, but only because of the antitrust position of the FTC. But the value of Steward's Utah operations did not suddenly go away just because one particular operator faced antitrust issues."

Hedgeye: Has HCA ever publicly disclosed or verified this purchase price? Also, that deal was negotiated well over a year ago with a buyer that can no longer be involved, and perhaps more importantly under much different macro, asset market and capital market regimes. We would bet that there has been value diminution since then. Also, we are quite certain that there would be no excess proceeds after any taxes + paydown of the ABL facility and debt owed to MPW. And in the process Steward would be materially impairing the go forward profitability of the system given Utah's outsized EBITDAR contribution. And that's assuming it can even get done, which is a stretch given that we believe the two most likely bidders (Prime and Intermountain) are themselves capital constrained. It would also be contingent on those buyers underwriting and agreeing to assume the in-place rent to MPW, which as we just saw with Prospect is a nice narrative but not always a reality. But we shall see! If Steward somehow got the Utah portfolio sold, it would likely cause a near-term pop in the share price to be sure.

Steve Hamner, CFO: "And this is why, during the earlier part of this year when Steward was working out the issues I just described, that MPT elected to fund a loan to Steward rather than require Steward to borrow from another lender. Another lender would have required MPT to relinquish our existing and powerful security position and the value of Steward's best operations, a position we have by virtue of our master lease, security agreements, and inter-creditor agreements."

Hedgeye: Does that not imply that, absent MPW's involvement, Steward could have likely defaulted? That is an interesting question for a company (MPW) with no ability to raise attractively-priced capital right now. It also indicates that MPW is more involved and exercises more influence/control over Steward than it lets on.

Steve Hamner, CFO: "Some analysts and investors have opined that our Prospect investments are not among our stronger assets. And while we will not comment on that observation this morning, if it is true, then the Yale transactions will be an especially notable financial result for our shareholders and for our underwriting."

Hedgeye: Come on, man. Really? Look at your own published EBITDAR/EBITDARM coverage schedule, which shows negative coverage at Prospect. It also appears that Prospect is being forced to eat the different between the $457 million paid to MPW and Yale's likely ~$400 million purchase of the WholeCo. Does Prospect have that money? And how will MPW make Prospect "hole?"

MPW: Reported ~5.8x adj. net debt to / annualized EBITDA in its 3Q22 supplemental.

Hedgeye: We calculate ~8.4x leverage on a pro-rata look-through basis, using annualized cash EBITDA and excluding transactions that have not yet closed. This is consistent with estimates we published pre-3Q22. We feel strongly that a cash metric is more important for MPW given its high % of straight-line rent, overall high leverage, tenant credit issues and tightening dividend coverage.

Q&A:

Steve Hamner, CFO: "On the ABL, what Steward announced a few weeks ago was that they had an extension till the middle of December, and during which time they expected to complete documentation requirement to presumably extend that for a full year beyond the time they delivered those documentation requirements. It's our understanding that the primary documentation is delivery of the 2021 audited financial statements.

Hedgeye: Steward said no such things regarding the length of the extension period or any documentation requirement. These statements are not true, and are readily observable. MPW did not distribute a press release or file an 8-K on this matter, despite the materiality of Steward's solvency to MPW.

Ed Aldag, CEO: "We do not have any knowledge or needs – foreseeable need that we would need to loan any money to any of our tenants for any rent needs."

Hedgeye: Noted for the future. In the spirit of that question, which tenants received the newly disclosed ~$267 million in investments on page 15 of the supplemental (see Figure 3 below), which went unmentioned and unquestioned? And what was that money used for?

Ed Aldag, CEO: "... I've been doing this for almost 38 years."

Hedgeye: Tell us more about it!

Ed Aldag, CEO: "To date, we do not have any facilities that we have seen substantial and material deferments of CapEx."

Hedgeye: Every single hospital investor, broker or employee that we have spoken to since beginning our work on MPW has said the exact opposite.

Steve Hamner, CFO: "But if we issued 10-year U.S. today, it's probably going to be 8+ percent."

Hedgeye: We'll take the "over" on that one. Look at what the '31's are yielding right now.

Steve Hamner, CFO: "I think the conceptual thing to remember, Josh, is with respect to rents, to the landlord rents especially on acute care hospitals, it's a relatively small piece of net revenue, generally around 5%. So when it comes to inflation pressures, hospitals aren't focused on paying a little bit higher rent on 5%."

Hedgeye: The above-market, uneconomic rent (fixed expense, akin to leverage) paid to MPW is the primary reason why several of these hospital systems are distressed or insolvent. A rent burden at ~5% of revenues or higher (as in the case of Steward, demonstrably) is completely unsustainable for a mid-to-high single-digit pre-rent operating margin business.

Steve Hamner, CFO: On the Wadley development, "... Steward commenced active pre-development for the Wadley Hospital about this time last year, sometime in mid-to-late 2021. And then later that year, MPT made an initial advance funding. And then in 2022, Steward accelerated trying to line up and pre-fund or at least pre-identified in recognition of supply constraints, materials cost and lining up contractors and general contractors."